Crowdfunding Efforts Draw Suspicion

Regulators are scrutinizing about 200 websites set up by entrepreneurs to profit from a more lenient law on the sale of shares in small companies.

Regulators are scrutinizing about 200 websites set up by entrepreneurs to profit from a more lenient law on the sale of shares in small companies. Rick Brooks joins digits. Photo: Kickstarter.

State securities officials identified the websites after a sweep of thousands of Internet addresses for possible threats to investors following the looming change.

The probe was triggered by the Jumpstart Our Business Startups, or JOBS, Act, which dismantles many of the legal constraints on small companies selling shares on the Internet.

Securities laws currently prohibit private companies from advertising or selling shares to investors who aren't relatively wealthy. The JOBS Act will allow companies to raise up to $1 million a year through small share sales to ordinary investors.

ENLARGE

Jason Schneider

When President Barack Obama signed the JOBS Act bill last April, he hailed these "crowdfunding" provisions as a possible "game changer" that would allow "ordinary Americans…to go online and invest in entrepreneurs they believe in."

Supporters also predict a boost for capital-starved small companies.

But some regulators are concerned that forthcoming rules to relax existing controls might present opportunities for fraud. The Securities and Exchange Commission missed a Jan. 1 deadline in the law to write crowdfunding rules, but a spokesman said the agency is working to adopt effective rules "as soon as possible."

In anticipation of the rules, the North American Securities Administrators Association, which represents state securities regulators, is taking steps to try to weed out possible problems lurking among thousands of nascent crowdfunding operations.

9,001

Internet names with the word "crowdfund," up from 900 in Jan. 2012

In a year-end trawl of the Internet, the association of securities regulators found 9,001 website names containing the word "crowdfund," according to a spokesman. The total is up more than tenfold from a year earlier. Officials have reviewed about 2,000 of those site names, concluding that about 200 need a closer examination or monitoring, the spokesman said.

The Wall Street Journal reviewed a list of the 9,001 website names being sifted by regulators. Some names appear to cater to specific groups of entrepreneurs or investors based on their gender ("crowdfundgirl"), race ("latinocrowdfunding") or religion ("christiancrowdfunds").

The eclectic mix also includes names seemingly aimed at sparking investor interest, such as "getrichcrowdfunding" and "crowdfundingjackpot."

Not all the site names are owned by entrepreneurs. Some belong to companies that specialize in buying and selling Internet addresses.

State regulators already have taken or considered enforcement action against a handful of companies for allegedly exploiting online fundraising to commit fraud—or simply jumping the gun on the planned rules changes.

One example of an allegedly overenthusiastic entrepreneur is Stephen Rea of Little Rock, Ark. According to the website for his company, Mr. Rea invented his trademarked "Xtender Strips"—fabric extensions to hook-and-loop fasteners, or Velcro strips—in 15 minutes at a Wal-Mart Stores Inc.WMT-0.25% superstore.

A separate website Mr. Rea set up inviting investors to "Send Yo Money!" claimed to be operating "under" the JOBS Act, while his company's site solicited "crowdfunding" financing. After an Arkansas regulator spotted the websites, it contacted Mr. Rea, who agreed to make it clear on the site that he isn't selling shares.

Heath Abshure, the Arkansas securities commissioner and president of the association of securities regulators, said he decided not to take enforcement action because of Mr. Rea's cooperation and lack of sales, as well as the fact he didn't appear to intend to break the law. Mr. Rea declined to comment.

Massachusetts Secretary of the Commonwealth William Galvin last year alleged that Christopher Melville and his game-store company, Tabletop Arena LLC, committed "crowdfunding fraud." An administrative complaint said Tabletop broke securities laws in trying to raise at least $250,000, allegedly encouraging customers to invest using incentives such as free dice "under the banner of crowdfunding."

Mr. Melville said his crowdfunding efforts hadn't succeeded in raising money and that the action has been settled, adding his company is "doing really well."

Crowdfunding enthusiasts say the number of websites being registered reflects the pent-up demand for the financing targeted by the JOBS Act. "This is something of a vindication of the concept," said Sherwood Neiss, a principal of consulting firm Crowdfund Capital Advisors.

Research his firm is working on with the University of California, Berkeley, suggests the crowdfunding market could be worth $4.6 billion annually within five years, he added.

Supporters of crowdfunding say the states' fraud warnings are overblown, noting the real danger is that national regulators will choke off the industry before it gets going. "There's a great concern the rules will be so burdensome they won't be operable," said Jonathan Sandlund, founder of information website The CrowdCafe.

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